Coffee Break

Last week in a nutshell

• De-escalation in the Middle East has put the focus back to fundamentals as the Q1 earnings season has started on a solid footing thanks to upgraded earnings expectations, led by Technology and commodity-linked sectors. However, a solution to the conflict remains absent and the Strait of Hormuz remains key to the way forward.
• A divergence between the Eurozone and the US has emerged, with the former showing disappointing PMI data whereas the latter had both services and manufacturing coming in better than expected and pointing to continued growth.
• The negative sentiment in Europe is also visible in the latest IFO report, where the latest data came in at the lowest points since 2020. Sentiment in the US however (University of Michigan) improved and even beat expectations.
• In the Eurozone PMI data, the input prices rose at their fastest rate since December 2022, confirming the impact of rising energy prices in the broader economy.
• The Warsh hearing confirmed previous assumptions. He prefers a smaller balance sheet and remains in favor of Fed independence. What was more striking however was his take on Fed communications. He prefers streamlining press releases and a unisono voice from the Fed.

Investment convictions

Core scenario

• Tactical neutrality: With negotiations ongoing and a ceasefire in place and lengthened, there’s room for markets to relax. In this scenario, we prefer to tactically remain close to a neutral positioning on equities.
• Monitoring the situation in the Middle East closely. We remain ready to re-engage with risk assets should the Strait of Hormuz reopen, oil stabilise toward $80-85/barrel, and rate pressures ease. History shows geopolitical pullbacks are short-lived unless they become a sustained macro shock.
• Ahead of the start of the Iran war, a supportive macro context. Macro conditions remained supportive until early-March but are no longer the dominant driver of market leadership. US growth continued to rest on private domestic demand, with investment – especially AI-related capex – playing a larger role than consumption.
• Back to fundamentals. Markets have shifted attention back to corporate profit growth as the Q1 earnings season has started on a solid footing thanks to upgraded earnings expectations, led by Technology, Energy and Basic Materials.
• Monetary policy ambiguity. A Federal Reserve easing now seems conditional on the evolution of energy prices – we think the Federal Reserve is likely to look through the shock. The ECB will have to manage inflation expectations and is no longer “in a good place”; the ECB may adopt a more cautious stance, delivering a first 25 basis point hike in the coming months as an insurance policy move. This week’s ECB meeting will provide some insight. Finally, the Bank of Japan and the Reserve Bank of Australia remain in tightening mode.

Risks

• Iran war. The duration of the war and the effective closure of the Strait of Hormuz, the diffusion towards other countries and beyond energy commodities to soft commodity prices, and the damage to the energy infrastructure in the region represent the key risks for the growth / inflation
• Geopolitical fragmentation. The US–China rivalry remains entrenched, while energy supply and global trade patterns continue to shift.
• Fed dilemma. The oil shock and a divided FOMC could delay further easing, risking a pause in liquidity support. There is a risk that tariff-related price gains together with energy price related pressure, could lead to some inflation increases over the coming months.
• Fiscal credibility. Rising issuance and political noise could test bond market confidence and trigger volatility in yields.

Cross asset strategy

• We are tactically neutral on equities while the ceasefire persists and negotiations are ongoing.
  • Our overall positioning is Neutral
• Regional allocation:
  • United States: Neutral: The United States remain relatively more insulated thanks to domestic energy production and still-resilient private demand. Attractive Tech valuations represent a support for the stock market.
  • Japan: Neutral: structural energy import dependence, but a supportive government policy
  • Europe: Neutral: acute exposure to Middle Eastern oil and LNG dynamics and vulnerability to renewed headline inflation. On the other hand, fiscal spending is kicking into full gear.
  • Emerging Markets: Neutral: The region was one of the best performers year-to-date until early-March, but in the new geopolitical environment it is also vulnerable to higher oil prices and a rising USD. In case of a negotiated peace agreement, this sentiment could quickly reverse.
• Factor and sector allocation:
  • We remain constructive for both Technology and Healthcare. Within the software sector, a large dispersion of business models exists, some of which are more impacted by Artificial General Intelligence than others.
  • We keep some exposure to EU and US mid-caps as they are somewhat shielded from expansionary budgets and planned deregulation.
• Government bonds:
  • We are neutral on core European duration. A spiking oil price, if it remains at elevated levels, is already feeding through in interest rate expectations for the ECB. We are monitoring an attractive entry point.
  • US Treasuries remain Neutral, with the upcoming Fed reshape adding complexity.
• Credit:
  • Spread widening in European Investment Grade (IG) has been very limited, insufficient to create a broad valuation opportunity while macro uncertainty remains elevated. IG fundamentals remain solid, but sensitivity to higher rates warrants a neutral positioning. With dispersion increasing, we favour maintaining selectivity rather than holding an overweight position.
  • Neutral on IG credit in both the US and Europe. High Yield technicals are deteriorating amid outflows and increasing supply. Within HY we’re neutral on European HY and negative on US HY.
  • Emerging Market debt is neutral. Emerging markets face a challenging backdrop of higher yields and rising volatility but the US dollar is no longer strengthening and real yields are attractive. Hence, a neutral stance on both EM local debt and corporates is warranted.
• Alternatives:
  • We remain constructive on gold over the long term. We note the increased volatility in the short-term.
  • We hold precious and strategic metals, alternatives and market-neutral strategies for portfolio stability and diversification.
• Currencies:
  • The current market regime favours currencies linked to commodities such as precious metals and oil. Therefore, we have long positions in AUD, NOK and BRL.
  • There is now an increased potential of a better relationship with the EU for Hungary which could lead to more stable policies and therefore a meaningful reduction of risk for foreign investors, leading us to add the Hungarian Forint.
  • We remain underweight on the USD but have reduced this underweight materially on renewed geopolitical escalation.
  • We are also long JPY.

Our Positioning

Global markets were more mixed this week. Equities lost momentum as the earlier relief rally faded, with earnings still offering some support, but investors grew more cautious as tensions in the Middle East remained unresolved and oil prices stayed elevated, capping the upside for risk assets. On the data front, the transatlantic contrast remained striking. US flash PMIs improved, suggesting the economy is still absorbing the energy shock relatively well, but the sharp rise in output prices points to renewed inflation pressure. In the euro area, by contrast, flash PMIs slipped back into contraction territory, underlining a weaker growth backdrop. Notably, input prices in European PMIs also rose sharply, complicating the outlook for the ECB.

We are currently tactically neutral on equities. The current ceasefire is a significant first step, allowing markets to catch a breather and diplomatic initiatives to be worked out. We remain prepared to act quickly in either scenario: further de-escalation, or a resumption of the war. In giving peace a chance, we prefer to be neutral since the outcome of the negotiations is de facto binary. In fixed income, we are neutral on core European duration and on global bonds in general. Finally, we are neutral on Emerging market debt, for both hard and local currency.